Downgrade affects $281.4 million of rated debt outstanding
New York, November 27, 2012 --
Moody's Investors Service has downgraded The University of Michigan Hospitals
(UM Hospitals) to Aa3 and Aa3/VMIG 1 from Aa2 and Aa2/VMIG 1. The
rating action affects $281.4 million of outstanding hospital
rated debt issued by the Regents of the University of Michigan.
The outlook is stable at the lower rating level.
SUMMARY RATING RATIONALE
The downgrade reflects a marked decline in operating performance in fiscal
year (FY) 2012 resulting in a very low adjusted operating cash flow margin
of 2.9% after transfers (7.9% before transfers),
continued low 3.0% cash flow margin in the first quarter
of FY 2013, and expectations for continued pressures that will keep
operating cash flow low in full FY 2013. Additionally, cash
on hand deteriorated in 2012, along with a multi-year decline
in cash-to-debt with growing total direct debt load.
These challenges are countered with UM Hospitals preeminent reputation
with a wide draw for patients, status as a component unit of the
Aaa-rated University of Michigan, well-developed health
system network with the Medical School and faculty, good cash flow
generation before independent transfers back to the university,
declining external debt load, and completion of major capital projects.
The self-liquidity debt is managed by the treasury department of
the university, and the VMIG 1 rating is based on The University
of Michigan's strong internal liquidity and treasury management and dedicated
bank line.
CHALLENGES
*Steep decline in operating cash flow driven by increased expenses
of opening the new women's and children's hospitals and implementation
of new clinical information technology. In FY 2012, Moody's-adjusted
operating cash flow declined to a very low 2.9% after transfers
from a thin 5.2% the prior year. Management anticipates
continued operating pressures and has instituted improvement initiatives;
*Sizeable transfers to The University of Michigan Medical School to
support strategic operating needs and substantial recent capital investment
of UM Hospitals weaken operating and debt measures when including transfers
in expenses and loans from the university as direct debt, resulting
in much lower metrics including peak debt service coverage of 2.00
times (down from 2.83 times the prior year and unfavorable to Aa3
median of 5.6 times);
*Revenue pressures with shifts from commercial to governmental payers
and non-pay patients as well as more moderate rate increases;
*Multi-year decline in cash on hand; 12% decline
in absolute liquidity in FY 2012 with cash on hand declining to 179 days
from 215 days at the end of fiscal year 2011 and from 303 days at the
end of fiscal year 2008; unfavorable to Aa3 median of 235.5
days.
STRENGTHS
*Preeminent reputation as a quaternary academic medical center with
a wide draw of patients from across the state and out-of-state;
*Consolidated unit of The University of Michigan (rated Aaa),
with strong ties through inter-university transfers, commingled
investments, and loans to the hospitals from the university to support
sizable capital projects, and plans to refund the hospitals'
outstanding revenue secured debt;
*A well developed interrelationship with the Medical School and faculty
practice plan to create a focused strategic direction for the university
health system as a whole;
*Completion of major capital projects in FY 2012, including
the recently opened Children's and Women's hospitals, to increase
capacity and enhance services; near-term capital expected
to be funded largely through cash flow and philanthropy, without
any major additional increase in debt.
Outlook
The stable outlook reflects the strong relationship and oversight by University
of Michigan, with a goal to create efficiencies and improve operations.
The outlook is further supported by our belief that UM Hospitals will
continue to generate good cash flow before transfers to support its rated
debt load, while maintaining a good liquidity position. New
construction projects will add additional capacity to meet growth in volumes
and to provide additional revenues and cash flow. In the short
term, however, performance in FY 2013 is expected to remain
challenged with additional costs associated with opening the new hospitals
as well as increased investment in information technology.
WHAT COULD MOVE THE RATING UP
Marked improvement in operating cash flow generation and resulting increase
in debt service coverage (after transfers); material decline in total
debt load
WHAT COULD MOVE THE RATING DOWN
Continued weak cash flow and debt service coverage and narrowing liquidity,
material increase in non-intercompany debt load without commensurate
increase in cash flow; material declines in market share; deterioration
of the university's credit strength
PRINCIPAL METHODOLOGY USED
The principal methodology used in this rating was Not-For-Profit
Healthcare Rating Methodology published in March 2012. Please see
the Credit Policy page on www.moodys.com for a copy of this
methodology.
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The Global Scale Credit Ratings on this press release that are issued
by one of Moody's affiliates outside the EU are endorsed by Moody's
Investors Service Ltd., One Canada Square, Canary Wharf,
London E 14 5FA, UK, in accordance with Art.4 paragraph
3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies.
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Moody's downgrades University of Michigan Hospitals (MI) to Aa3 and Aa3/VMIG 1 from Aa2 and Aa2/VMIG 1; outlook is stable at lower rating level
